Working Paper: NBER ID: w16058
Authors: Geert Bekaert; Robert J. Hodrick; Xiaoyan Zhang
Abstract: We examine aggregate idiosyncratic volatility in 23 developed equity markets, measured using various methodologies, and we find no evidence of upward trends when we extend the sample until 2008. Instead, idiosyncratic volatility appears to be well described by a stationary autoregressive process that occasionally switches into a higher-variance regime that has relatively short duration. We also document that idiosyncratic volatility is highly correlated across countries. Finally, we examine the determinants of the time-variation in idiosyncratic volatility. In most specifications, the bulk of idiosyncratic volatility can be explained by a growth opportunity proxy, total (U.S.) market volatility, and in most but not all specifications, the variance premium, a business cycle sensitive risk indicator.
Keywords: Idiosyncratic volatility; Market efficiency; Diversification benefits
JEL Codes: G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| idiosyncratic volatility across 23 developed equity markets from 1980 to 2008 (G15) | no significant upward trends (P27) |
| idiosyncratic volatility (G19) | highly correlated across countries (O57) |
| growth opportunity proxy, total US market volatility, and variance premium (G17) | time variation in idiosyncratic volatility (C22) |
| market volatility and cyclical risk aversion (E32) | idiosyncratic volatility (G19) |